Credit Suisse First Boston analysts are taking a bearish view of gas prices in 2004 but believe gas pipeline companies and local distributors (LDCs) should see higher valuations because of the current focus of investors on balance sheet repair rather than on high commodity prices.

“While our overall thesis reflects tight supply-demand dynamics and positive trends, in pricing, the current rally in natural gas prices to over $7/Mcf has valuations at levels that rest more on psychology than fundamentals,” said CSFB analysts Philip Salles. His comments were released on a day when gas futures prices tumbled more than 65 cents, or about 9%, to $6.324/MMBtu (see related story).

Salles noted, however, that as of last Friday the January futures contract had increased 44% compared to December futures when it was the prompt month. The closely watched 12-month strip was at about $5.60 on Friday. The January 2003 and December 2002 futures contracts expired at $4.35 and $4.74, respectively, a year ago and the 12-month strip at this time last year was $4.17.

“We expect the current pricing strength to continue through 1Q04 and we look for a better correlation of valuations in the pipeline and integrated natural gas group,” Salles said.

He said the group currently shows a 25% discount, including a price/earnings ratio of 13.9 times compared to a historical 18 times when natural gas prices achieved peak levels. “The current valuation is closer to the trough of natural gas prices, suggesting that investors are still focused on balance sheet repair and recent issues as opposed to the opportunities that improved financial fundamentals represent in the current commodity price environment,” said Salles.

Despite his optimism about company valuations, Salles expects much weaker prices in 2004. “In our view, natural gas prices are likely to fall in 2004 and our natural gas price estimate for the year remains $3.85/Mcf.

“However, we believe company-specific issues will drive performance in 2004 and beyond, and that each day that prices remain above our estimate is an opportunity for the group to exceed expectations in earnings, cash flows and balance sheet repair.”

He said integrated pipeline company and LDC valuations are “depressed.” The shares of gas companies in the CSFB group (excluding Williams and Dynegy) are up 8% in the fourth quarter compared to a 9.5% gain in the S&P 500. Year-to-date, the group is up nearly 20% compared to the 24% move in the overall market.

Not all of the companies with large E&P divisions will benefit from the rich commodity price environment, Salles also warned. “In certain cases, we do not expect E&P value to easily translate into share price performance despite a step up in revenues and cash flows attributed to the higher prices. An example is [National Fuel Gas]. NFG has shown declining reserves and production as well as increasing costs in recent years and looks to continue to deteriorate.”

Questar (STR), however, has a growing E&P unit with additional drilling opportunities, Salles said. “Our neutral rating for STR relates to concerns about the regulatory environment and timing of new production.”

He said Sempra and Oneok should see improvements from their unregulated energy services and marketing businesses. Increased capital spending, new pipeline capacity and storage benefit are expected to help El Paso Equitable Resources, Kinder Morgan and Williams.

“In summary, current natural gas and overall market trends confirm our view that the owners of ‘hard assets’ offer the best opportunities, especially when regulated asset earnings and cash flows are enhanced by unregulated assets in exploration and production and other areas.”

©Copyright 2003 Intelligence Press Inc. All rights reserved. The preceding news report may not be republished or redistributed, in whole or in part, in any form, without prior written consent of Intelligence Press, Inc.